It’s Been a Long Time Coming (With apologies to Sam Cooke, David Crosby and Taylor Swift)

I thought that by 2023 the US economy would have entered a recession. My favorite recession indicators, the yield spread between the Treasury 10-year security and the federal funds rate and changes in real “thin-air” credit, both suggested a recession was imminent. When the yield spread enters negative territory and remains negative for as long as it has of late (see Chart 1), since 1970, a recession has occurred. But not this time. Similarly, when the yield spread persists in negative territory, typically, real thin-air credit (depository institution holdings of loans, securities and reserves deflated by the Gross Domestic Purchases chain-price index) contracts and a recession is underway (see Chart 1). The percent contraction in real thin-air credit of late has been the largest since the Great Depression. But still no recession. It’s been a long time coming, but I do believe the US economy finally stands on the precipice of a recession.

Although the magnitude of the rate of contraction in real thin-air credit starting at the end of 2021 has been the largest since the Great Depression, the growth in real thin-air credit starting in 2020 was the fastest since time immemorial. So, although real thin-air credit has been contracting in recent years, this contraction has not been sufficient to reduce the level of nominal thin-air credit outstanding. Nevertheless, nominal thin-air credit as a percent of nominal Gross Domestic Purchases has declined since its highs of 2020-21. In Q1:2024, this percentage, 82.6%, was inline with the percentage in 2017. The implication of this is that the “excess” thin-air credit created in 2020-21 has come into line with the level of domestic purchases of goods and services in the economy. In other words, future growth in domestic spending will have to be “financed” out of current income.

The sector of the economy that usually weakens prior to a recession is residential housing. Cracks in the foundation of housing are not starting to occur. According to the National Association of Realtor’s affordability index of housing, an index that incorporates, the median price of an existing house, the median income of households and the level of the 30-year mortgage interest rate, housing is now less affordable than it was in 2006, which was near the end of the housing bubble (see the blue line in Chart 3). As housing affordability has declined in recent months, so have combined sales of new and existing single-family homes (the red mass in Chart 3).

It now appears that inventories of new completed single-family homes for sale are rising relative to homes sold (the blue mass in Chart 4). This percentage in May 2024 shot up to 198.4%, within a hair of the previous high of 200.4% reached in January 2012. If inventories of new homes are becoming excessive, why should builders apply for permits to start new ones? The decline in permits for single-family houses in recent months (the red line in Chart 4) would be consistent with the notion that new-home inventories are becoming “top heavy”.

After laying off 100 workers earlier in the year, Mercury Marine announced on June 15 that it was laying off an additional 300 workers at its Fond Du Lac, Wisconsin facility. Now, 400 workers is a rounding error in terms of total nonfarm payrolls. But the reason Mercury Marine gave for these layoffs might be a harbinger of things to come regarding consumer spending. Mercury Marine demand said that the demand for outboard engines from pleasure-boat manufacturers had slowed. Pleasure boats are a pure discretionary item. When household budgets get tight, the first things they cut back on purchasing are by definition, discretionary items. By the way, at the close of equity trading on July 9, the stock price of Brunswick Corp., the largest U.S. manufacturer of pleasure boats, was down 26.8% year to date. The stock of another producer of a discretionary item, Harley-Davidson (HOG) is not doing well either, down 12.29% year to date.

Chart 5 illustrates that growth in real consumer spending has slowed dramatically in the five months ended May 2024. In this period, annualized growth in real consumer spending for goods and services was 0.83%, compared with 3.25% in the five months ended December 2023. Household purchases of real goods contracted at an annualized 2.12% in the five months ended May 2024, compared with growth at an annualized 3.63% in the five months ended December 2023.

And if consumer demand is slowing, might it be likely that businesses would slow the rate at which they are adding new employees? The data in Chart 6 suggest that businesses have slowed their hiring rate. In the three months ended June 2024, annualized growth in nonfarm payroll employment slowed to 1.30%, the slowest three-month hiring rate starting in January 2022.

It’s been a long time coming, but it looks to me that the US economy stands on the precipice of a mild recession. I expect the inflation data over the next several months to show continued moderation or, at least, no acceleration, If so, look for the Fed to begin a series of cuts in federal funds rate at its September 17-18, 2024 meeting. That would be too late to avoid a mild recession but soon enough to prevent a serious one.